Emphasis on oversight instead of incentives binds philanthropy

New Delhi: In the last decade and more, an entirely new breed of philanthropists have begun to emerge, taking the business of giving to an entirely new trajectory.

The significance of their contribution is not so much in terms of the size of their funding; instead it is in the fact that they are doing so without a complementing ecosystem, especially with respect to fiscal structure.

Not only does it not create incentives that would encourage greater philanthropy, as the US does with its inheritance tax, the focus of the tax authorities is now shifting to prevent misuse of the existing concessions by a few rogue not-for-profit organizations.

While the intent is well placed, a uniform approach, fear experts, could result in unintended consequences especially given that there are all kinds of non-profits engaged in a myriad set of activities.

“Government should take civil society stakeholders as partners,” says Vipin Sharma, chief executive officer of Access Development Services, a non-profit working with microfinance institutions and on livelihood options.

Sharma’s apprehensions flow from a notification issued by the income tax (I-T) department in December 2008 that tightened definition of charitable organizations. “It makes carrying out operations tougher,” says S.P. Mishra, associate vice-president at Access and Sharma’s colleague.

Though the I-T department’s amendment—section 2(15)—is over two years old, the lag between notification, filing and assessments means the outcome of tightening definitions of charitable organizations will be tested this year, says Sushil Shah, partner at tax consultancy Deloitte.

The key sentence in the notification that is causing concern among non-profits is, “It was seen that a number of entities who were engaged in commercial activities were also claiming exemption on the ground that such activities were for the advancement of objects of general public utility in terms of the fourth limb of the definition of charitable purpose.”

The fourth limb in the definition is the advancement of any object of general public utility.

A member of the central board of direct taxes, who spoke on condition of anonymity, pointed out that recent legislative changes were in sync with global practices, though the person admitted that the key motive was to prevent commercial organizations using non-profits as a cover to avoid paying taxes.

Experts say the 2008 notification could well be a big dampener for non-profits.

One implication is that the I-T department will raise a lot more queries on revenue generating activities of charitable organizations. It could be something as commonplace as selling New Year cards to raise money.

Earlier, such an activity could be tax exempt as the non-profit could claim that it was for the purpose of furthering the cause of charity. Now, that may be tougher as one of the aims of tightening the definition is to tax anything in the nature of business.

The outcome will depend to a large extent on the interpretation of the I-T department or assessing officers. “If a person is carrying on trade or business…is a matter of opinion,” says Shah.

One solution suggested by non-profit organizations is that I-T department invest in creating a special wing or a pool of officers to assess their tax returns. “Maybe there should be a separate assessing unit for NGOs,” says Mishra. An opinion which is echoed by Deval Sanghavi, founder and chief executive officer of Dasra, a venture philanthropy fund.

It is not clear as to whether the I-T department will effect the desired change, though it has initiated specialization on the subject of international taxation, a new and lucrative, but controversial, revenue source. The impetus for doing so is entirely different. Some tax experts dismiss the demand made by non-profits.

“It’s not so complex,” says Shah. “It’s not a subject by itself.”

Internationally, some countries have begun to make it easier for non-profits. “Singapore is getting more liberal,” says Sonu Iyer, partner at Ernst and Young. “I find Singapore is reversing to make it less restrictive,” she adds. According to Iyer, Australia does not have prescriptive rules.

Going forward the proposed direct tax code (DTC), that is to bring about seminal changes in the direct tax regime in the country, reflects the current perceptions of the tax authorities in dealing with non-profits. The first draft of DTC clearly stated that non-profits had been used as a vehicle for tax avoidance by commercial organizations. The draft ended their tax-free status and proposes a 15% tax on the surplus income generated by non-profits.

Further, the draft DTC retains the essence of the December 2008 tightening of charitable organizations. Experts believe that the proposed provision is taking a very short term view of development work as non-profits engage in projects with a gestation period of three to five years.

Sanghavi says the changes in the tax regime would force non-profits to revisit the structure of their present model. “In essence, you are taking away synergistic aspects,” he says, referring to the clamp-down on revenue generating activities of NPOs.

In the circumstance, what may evolve is a hybrid model, where the revenue generating activities, which attract a tax, would be spun-off into a for-profit enterprise says Sanghavi.

While the outcome of this is still unclear, the bigger worry is that tighter scrutiny and new rules are happening without creating an incentive structure to encourage growing number of wealthy entrepreneurs in the country as donors.

This is significant because increasingly it is evident that India’s new-found economic prowess is beginning to hurt its ability to draw fresh global aid. Home-grown philanthropy would, therefore, potentially be an alternative means of funding and developing social sector projects.

If that is indeed the government’s surmise, then the fiscal incentives and controls have to be revisited.